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Likelihood Corrections for Two-way Models

Author

Listed:
  • Koen Jochmans
  • Taisuke Otsu

Abstract

The use of panel data models with two-way fixed effects is widespread. Incidental-parameter bias, however, invalidates inference based on the (profile) likelihood. We consider modifications to the likelihood that yield asymptotically-unbiased estimators as well as test statistics that are size correct under rectangular-array asymptotics. The modifications are widely applicable and easy to implement. Through several examples we illustrate that the modifications can lead to dramatic improvements relative to maximum likelihood, both in terms of point estimation and inference.

Suggested Citation

  • Koen Jochmans & Taisuke Otsu, 2019. "Likelihood Corrections for Two-way Models," Annals of Economics and Statistics, GENES, issue 134, pages 227-242.
  • Handle: RePEc:adr:anecst:y:2019:i:134:p:227-242
    DOI: 10.15609/annaeconstat2009.134.0227
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    File URL: https://www.jstor.org/stable/10.15609/annaeconstat2009.134.0227
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    Keywords

    Fixed Effects; Information Bias; Modified Profile Likelihood; Panel Data; Penalization; Rectangular-Array Asymptotics;

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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